An Uplifting Tale from Japan

KYOTO, JAPAN IS HOME TO BUDDHIST temples, the celebrated geisha district of Gion -- and the
Wacoal
Brassiere Museum. Here you will find the first brassieres manufactured by Koichi Tsukamoto in 1946 after he was released from military duty. His firm, Wako Shoji, wholesaled women's dresses and accessories at a time when Japan was rapidly westernizing and women ceased to wear the kimono and the obi.

Enter the brassiere. At first, Tsukamoto dutifully copied the bras pictured in the Sears catalog. Soon, he forayed into other designs. By the 1970s, he began making bras that would let you look bra-less, and hold your head high among your bra-burning friends. New materials and designs followed and the company, now called Wacoal, acquired a reputation for luxuriousness and good fit.

In 1971, Wacoal listed on the first section of the Tokyo Stock Exchange. In 1987, Tsukamoto's son Yoshikata took the reins of the company. For the fiscal year ended this past March, Wacoal earned &yen;3 billion (about $27.9 million) on an operating basis on &yen;163.2 billion in sales. This year, the company expects to earn &yen;13.6 billion on an operating basis on &yen;166 billion in sales.

Wacoal shares are up 25% this year to &yen;1,101, for a recent market cap of &yen;159 billion (about $1.4 billion). Some believe they're worth far more. By the calculations of Charles de Vaulx of the First Eagle funds, net cash accounts for &yen;95 billion, or 60% of Wacoal's market cap. Wacoal trades at about 7.8 times earnings before interest, taxes, depreciation and amortization, and slightly below tangible book value.

The company could boost its stock price more swiftly, and that's the reason Peter Boardman, a Japan specialist at NWQ Investment Management, recently has bought shares. "It's about cost cutting, about downsizing production in Japan, and about shifting production into China," Boardman says. "This is the classic Japanese manufacturing story. And the valuations are extremely attractive."

Wacoal, still heavily dependent on department stores, has been troubled by slow sales. In August, Wacoal's sales to retailers were down 5%, which the company blamed on hot weather and the Olympics, which kept customers from shopping. Wacoal readily admits that its full-year forecasts are probably at risk because of the slow first half, and that it needs to mark down inventory for the second half. In the fiscal year ended March, the company's operating margin was 3.5%, down from 5.9% three years earlier because of pension-related and other charges.

We caught up recently with Shoichi Suezawa, Wacoal's CFO, in Wacoal's corporate headquarters above the bra museum. No snickering here: Suezawa and his colleague, Haruo Murata, are all business about underwear.

He thinks sales will jump to &yen;3.5 billion this year, from &yen;2.4 billion last year. And the sales are also going well elsewhere in Asia. Then there's "wellness wear" -- clothing you might wear to your yoga class, sold in places like Paragon Sports in New York.

Some of the glitches come from undersupply -- in the U.S., for example, and in China. That's changing. In China, Wacoal's sales are up nearly 150% to about &yen;800 million. Suezawa thinks those will grow swiftly, to &yen;3 billion in '06, and then to &yen;5 billion in '08, as the Beijing Olympics stokes tourism and sales.

Meantime, Wacoal is cutting costs by shifting production from Japan to China, Vietnam and elsewhere and reducing warehousing costs. Right now, a fifth of the company's products are made outside Japan, and the number can only grow.

Wacoal also prides itself on its new products (its "Human Science Research Center" boasts measurements for 30,000 women from teens to those in their sixties). And some of its products are hugely successful. It has missed sales targets in China because of insufficient stock of the surprisingly successful Nami-Nami bra, with side panels made of a cloth so strong the garment requires only a single layer. That means the bra is virtually invisible. Another hot item is the Shakitto bra, which has a side cloth and strap that Wacoal believes improves posture. "This is revolutionary," Suezawa says.

All the investment ought to bear fruit by the year ending March 2007, when Wacoal thinks total sales will climb to &yen;190 billion, with sales from SPA shops up to &yen;9 billion from &yen;2.4 billion this past March, catalog sales up to &yen;12 billion from &yen;6.7 billion, and "wellness wear" sales rising to &yen;10 billion from &yen;5.6 billion. Wacoal also points out that it's retired &yen;10 billion of shares in four years.

It still isn't enough for First Eagle's de Vaulx, who thinks Wacoal ought to buy back shares more quickly, and moans about the company's forays into retail, where they have "no expertise, so we're skeptical of their ability to be profitable." Yet he doggedly stays in the stock, reasoning that if management doesn't boost results, a newly active corporate Japan could do it for them.

Says de Vaulx: "It's a legitimate brand and they could produce a lot more overseas and it's not controlled by anybody. It's a perfect target, let's face it."

HOW DO YOU BUILD A BUSINESS in China? It's a great question for Wall Street, and Jose Linares, the head of Asia research for J.P. Morgan, thinks he has the answer. The quality of analysis about China is generally "pretty poor," says Linares, "a bunch of cheerleaders who are maximum bullish when stocks are going up."

Foreign firms haven't done much with Mainland shares because the "A" market was only recently opened to foreigners. Yet clients are interested: Their firms compete with Chinese rivals, and getting China right would yield market share gains.

So Linares recently hired Frank Gong, a top-ranked economist who once worked at the Fed, away from Bank of America to be the bank's chief China economist. Key to the strategy is a Shanghai base, says Linares. And Gong is rapidly hiring analysts, 10 to date, including a British Petroleum alumnus.

It's been hard to find homegrown talent, Linares concedes: "If you aren't trained in a supply demand framework since you were young, how do you break that pattern of thinking? Five years down the road, it may change."

Don't think labor is cheap either. "Shanghai is global," he says. Eventually, Linares aims to put J.P. Morgan in the ranks of the top three most influential firms in Asia. According to Asiamoney, it's No. 5; to Institutional Investor, it's No. 4. That should help improve parent J.P. Morgan's results, which even President Jamie Dimon dubbed "terrible" last week.

WITH FEW FIRM INDICATIONS of how the fourth quarter was unfolding or how business conditions are shaping up for 2005, Asian equities were modestly weaker last week, though their performance in dollars was better.

Most earnings didn't surprise on the upside.
Chartered Semiconductor
squashed a rumor that lifted its shares that
Taiwan Semiconductor Manufacturing
would bid for the company. "Until people get convinced about the second half or about '06, we're locked in a range," said one institutional broker.

That was particularly the case for big tech issues, after disappointments from Samsung Electronics and LG Philips.

"Every economist in the world is downgrading growth in '05," says Mark Headley of the Matthews Asian Funds. "I am more comfortable with the outlook for domestic [Asian] demand than with the global environment. As a long term investor, I'd rather be buying a toothpaste maker than a global tech stock."

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